How to buy stocks in an over-bought market

The sharp recovery in the markets has taken most participants by surprise. The Sensex has moved up 22% over a period of 64 days, making India the best performing market since the start of this year. A Credit Suisse report says this rally is the second-longest since 1995. Foreign investors are once again looking at India favorably, and so far have pumped in Rs 27,000 crore in 2012.

No wonder, there are many smiling faces around Dalal Street, and many of them are sure that the good times are back again. Really? "The market is seeing a lot of interest from investors. Though concerns on oil and the Eurozone remain, low valuations and a GDP growth of 7-7.5% indicate the worst is behind us. Every dip is a buying opportunity," says Kartik Mehta, AVP (institutional research), Sushil Finance.

STRATEGY TO CHOOSE STOCKS

Before you call up your stock broker, there are a few things you need to keep in mind. One, nobody has anticipated this turn around, just go back to the predictions of the talking heads at the beginning of the year if you want a proof. Also, the current rally has been broad-based. That means almost every stock has gone up, and you have to be very careful while picking up stocks. "Since the rally has been sharp, valuations are high, so wait for a correction before you enter. Pick your stocks carefully and stay invested for 12-18 months as the markets are expected to be volatile in the medium-term," says Abhishek Jain, head of research at JHP Securities.

"Look for stocks whose prices have not moved up in the recent rally despite good results and strong fundamentals," says VK Sharma, head - private broking and wealth management at HDFC Securities. He gives an example: Gujarat State Petronet (GSPL), where the company posted a net profit of Rs 392 crore for the 9-month period ended December 2011, against Rs 356 crore for the 9-months ended December 2010.

However, the stock price has moved up to Rs 75 from Rs 72. He is also recommending companies which came up with IPOs during 2008-2010. "If the company is reporting good financial results post IPO, but the stock continues to trade below the IPO price, it could be a buying opportunity," says VK Sharma. One such stock which he has identified using this strategy is VaTech Wabag from the water treatment industry. While the IPO was offered at Rs 524 (adjusted for split), in August 2010, the stock now trades at Rs 436.

With the results season over for the third quarter, another way to spot stocks could be to look out for companies where stock prices have been beaten down due to one-off poor results. "Thermax and Cummins have been beaten down due to poor results. However the order book for these companies are strong, the management commitment is high, thus providing a buying opportunity for investors," says Kartik Mehta. Then there are analysts who recommend value stocks.